Speculation and hedging in currencies is achieved primarily through forex trading and futures contracts where the underlying asset is a particular currency. The value of a futures contract reflects expectations of the value of the currency when the contract expires, which is in contrast to the forex spot market where the values are based on current market values. There are several advantages to using currency futures rather than trading the currency in forex accounts:
- the futures exchange guarantees the transaction; thus, unlike in forex, there is no counterparty risk
- the futures market is more heavily regulated, so brokers are less likely to engage in fraud or other unethical behavior
- because all futures are traded on organized exchanges, there is much more price competition for orders, whereas in forex, the number of participants is much more limited on the electronic communications network that is used to trade forex orders, and even more limited if the broker is a dealing desk broker, where the forex traders are only trading with the broker, and no one else.
Another major advantage of futures is that, unlike FX contracts, which must be rolled over every business day, currency futures only need to be rolled over 4 times per year: March, June, September, and December. However, rolling over must be done by the trader, by offsetting the expiring contract with another futures contract that expires further in the future. Futures contracts, unlike FX contracts, are not rolled over automatically. CME Group, which lists most of the currency futures in the United States (US), publishes the official rollover date when traders are recommended to move their positions into the next contract month. The recommended date is 1 week prior to the official last trading day. However, it is better to rollover earlier when there is more liquidity. Volatility greatly increases in the last week before expiration.
In forex, interest rate differentials between a currency pair are either paid to the trader, if the trader is long on the currency with the higher interest rate, or the trader must pay the difference in interest, if short on the higher interest rate currency, every time a rollover occurs. Interest rate differentials do not apply to currency futures contracts. The only cost with rolling over a futures contract is the commission and the bid/ask spread, which is often only 1 tick.
Counterparty risk is greatly reduced because the exchanges generally require the brokerage firms to guarantee their brokers' transactions, so if the client of a particular broker has a negative balance and does not repay, then the broker must make good on the transaction. If the client, broker, and the brokerage firm all default, then the exchange will cover the deficit.
These are the most commonly traded currencies:
- euro (EUR)
- Swiss franc (CHF)
- Japanese yen (JPY)
- British pound (GBP)
- US dollar (USD)
- Australian dollar (AUD)
- Canadian dollar (CAD)
- US dollar index (DX)
Currency Futures Contracts
Currency futures have 3 standard contract sizes. Except for the British pound, a full-size contract represents 100,000 to 125,000 units of currency, mini-contracts are half of the standard, and E-micro futures are 1/10 of the original futures contract size.
Most futures contracts are closed out before delivery, but if the contracts are held on the expiration date, then the short seller must make delivery and the long holder must take delivery of the underlying asset. However, some futures contracts are cash-settled. Contract expiration is the date and time for a particular delivery month of a currency futures contract when trading ceases and the final settlement price is determined so that the delivery process can start. Currency futures contracts listed by the CME Group, which is the main futures exchange for currencies, sets delivery on the 3rd Wednesday of March, June, September, December, unless Wednesday is a holiday. The last trading day of CME currencies is on the 2nd business day before the 3rd Wednesday, which is usually the Monday before expiration, so the traders who do not wish to make or take delivery of the currency should exit their positions by the preceding Friday, if not earlier.
Contract Multipliers and Ticks
Almost all currency futures — except some e-micro futures and some lesser volume contracts — use the USD as the quote currency, which are called American quotations. The minimum change in value of a futures contract is the tick, equal to the contract size multiplied by the pip value of the currency. Ticks are always expressed in USD. Price changes in currency futures are calculated by multiplying the number of ticks by a constant multiplier, which is what a tick is worth in USD. The actual value of a tick will depend on the specific type of contract. Generally, the tick value for currency contracts varies, depending on contract sizes, which can range from Â¥12,500,000 to 62,500 British pounds, so it is easier to remember contract multipliers rather than sizes.
For most currencies, the tick value ranges from $10 to $12.50; however, it is $6.25 for the British pound. The euro, Swiss franc, and yen futures have the same tick value of $12.50. So if the exchange rate for the euro is $1.4550 and it moves to $1.4451, then that is a single tick and the short trader will have lost $12.50 while the long trader will have gained the same amount. The euro and the Swiss franc contracts each represent 125,000 units of the underlying currency, but the yen futures contract represents 12,500,000 units, because the yen is roughly equivalent to a US penny. The yen futures contract quote of 1.2240 would mean that the price of the yen is actually 1.2240, so ¥100 would cost $1.224.
Some futures contracts, such as the yen and the Canadian dollar, are quoted inversely to the way they are generally expressed in forex. This is because futures contracts always use the dollar as the quote currency (American quotations); in forex, because of priority rules, the yen and the Canadian dollar are quoted with the dollar as the base currency rather than as the quote currency. So futures contracts for the yen would be expressed as JPY/USD rather than the usual forex quote of USD/JPY. The resulting prices will, therefore, be inversely related.
To limit losses by clients, most FX trading platforms automatically liquidate client holdings as soon as their account balance drops below the margin requirements. Forex only has 1 margin requirement that applies to everyone at all times. In futures, however, there is an initial margin requirement that must be met when the account is opened. Afterward, the maintenance margin requirement, which is usually lower than the initial margin requirement, must be met at all times. There are also separate margin requirements for speculators and hedgers — speculators have higher margin requirements.
The National Futures Association (NFA) sets the leverage ratio for FX markets, but the margin requirements in futures markets are determined by the exchanges since they guarantee the trades. However, brokers will often have more restrictive requirements. Brokers will often adjust margin requirements, depending on market conditions. During fast-moving markets, margin requirements may increase significantly.
Futures accounts are marked to market every day, meaning that the net value of each account is determined at the end of the trading session, which for CME currency futures is 4 PM Central Standard Time. If an account increases in value, then margin is increased for that account — the increase is taken from accounts that have lost value. Because margin is increased or decreased daily, according to the account value, this margin is called variation margin.
Unlike the margin in stocks, the margin in a futures account is not borrowed money but is simply the equity necessary to ensure the performance of the contract, which is why the required margin in a futures account is sometimes known as a performance bond. Indeed, most brokers even allow using T-bills for margin, allowing the trader to earn a small amount of interest. However, if the broker must sell T-bills to maintain the necessary margin (aka "breaking a T-bill"), a fee will be charged that is usually much more than the interest earned on the T-bills. For this reason, many retail customers use cash to post margin.
When a margin call is issued, margin can be restored by liquidating positions, depositing more funds, or using option hedges. Once a margin call is issued, then the margin must be brought back up to the initial margin requirement, not the maintenance requirement. Unlike the early days, traders are not notified of a margin call by phone, but usually by email with details regarding open positions, required initial maintenance margin, the margin deficiency, and the current account value. Generally, futures brokers give traders at least 2 to 3 days to eliminate a margin call. However, deep discount brokers tend to be stricter in margin call requirements and are more likely to force liquidation.
Because day traders usually close their position before the end of the session, they usually have lower margin requirements. Day trading is a trade that is entered and exited in the same trading session. Because currency futures markets trade nearly 24 hours per day, a trade entered shortly after the session close and exited before the next trading session close on the following day is still considered a day trade. Generally, day traders, if they are creditworthy, have a margin requirement that is 50% to 10% of what the exchange requires. However, most brokers grant the more favorable margin requirements accorded to day traders only if their transactions are opened and closed between 7 AM to 2 PM central time, since liquidity is greatest during this period; some brokers may extend that to 4 PM.
Specific FX Futures
Futures on the major currencies generally have a contract size of 125,000 units and a tick value of $12.50. However, some contracts are different. For instance, the British pound has a standard contract size of 62,500 units, so the tick value and multiplier are $6.25.
Aussie and Canadian Futures
Because the major export products of Australia and Canada are commodities, the Aussie and Canadian dollar often move with commodity prices, so they are often called commodity currencies. Contract sizes are 100,000 units, so the tick value is $10. So if an Aussie dollar futures contract moves from 1.05342 1.0634, that would be a move of $1000, = (10634 − 10534) × $10 = $1000.
US Dollar Index
US Dollar Index was introduced in 1973 and represents the value of the dollar against a basket of major currencies: euro, yen, British pound, Canadian dollar, Swedish krona, and Swiss franc. The Dollar Index is traded on the Intercontinental Exchange, otherwise known as ICE. Because of the diversification provided by the Dollar Index, margin requirements are generally less than half that required on futures contracts for specific currencies.
With an index as the underlying asset, quantities are not treated as individual currencies but as relative values. Unlike currency futures, the size of the Dollar Index (symbol: DX) is determined by the value of the index. The Dollar Index futures are determined by multiplying the index value by $1000, so if the index is trading at 80.00, then the contract size is $80,000. Obviously, the contract size will vary with the index.
The traditional tick value of the Dollar Index was $10, but , in 2005, ICE decreased it to $5. The easiest way to calculate profit or loss is to consider only the numbers that yield the difference, then multiply by 5. So, for instance, if the dollar index moved from 80.221 to 80.218, then the short profit = (2210 − 2180) × 5 = $150.
Unlike most index futures, the ICE US Dollar Index is settled by actually delivering the currencies in proportion to their weight in the index to the seller of the futures contract, who pays the long position the final settlement price in USD.
E-Micro Currency Futures
The CME group introduced E-micro FX futures to lure smaller speculators from the FX market into the futures market. E-micro contracts are 1/10 the size of original sized futures contracts. For instance, the EUR/USD E-micro futures contract has a tick value of $1.25 and is the most highly traded e-micro futures contract.